Nonperformers Require New Approaches
Banks face unprecedented problems with asset quality. Their nonperforming assets are causing lost income, increasing administrative costs, and adding to the difficulty of raising new capital.
Lenders could, however, slash the administrative costs and perhaps earn income to offset the burden of nonperforming assets - if bank officers dared to try new approaches.
For starters, banks should consider forming cooperatives to handle nonperforming assets. Banks already cooperate in many ways. For example, most regions have a single debit card/ATM program to which most of that area's banks subscribe. Member banks gain significant savings and customers benefit from additional outlets.
However, bankers relinquish control of their nonperforming assets reluctantly, the common wisdom being that a real banker cleans up his own mess. Unfortunately, cleaning up today's messes requires special skills not available to most bankers.
Until recently, most nonperforming assets resulted from poorly conceived projects, incompetent or dishonest people, or changes in the market. Time, patience, and reasonable effort usually solved those kinds of problems.
Variety of Problems
With today's sluggish economy, that's not the case. The projects and businesses crowding the nonperforming lists face real problems that must be dealt with before the assets can be liquidated for reasonable value.
Those problems require special knowledge and abilities. A bank needs people who can lease retail space, rent apartments, and sell apartment houses. To cite another example, a bank needs someone who can take charge when the lead tenant of a mall files Chapter 11.
A bank must have people who can move single-family homes built on speculation; sell lots; plan for vacant space. In addition a bank must be prepared to get subdivisions approved, uses allowed, building permits issued, leases negotiated, tenant fit-outs completed, and much much more.
Expertise at a Premium
Every entry on a bank's nonperforming assets list presents a unique problem. And only money-center and superregional banks can afford the expertise needed to handle the problems.
For most banks, the staffing costs are prohibitive. If, however, a group of banks joined in a cooperative, they could employ or retain all the expertise required at an affordable cost to each member.
The cooperative would be separate from any of the banks, although it could be housed and administered by one member.
Each member bank would pay for time expended in its behalf. Members would be obligated to have the cooperative administer and collect their nonperforming assets. Nonmembers could use the cooperative on a problem-by-problem basis, paying a higher unit fee. The cooperative would account to members periodically and distribute any "profits."
Another step that banks should consider in solving asset quality problems is to hire in-house litigation specialists.
An associate active in a very successful bank collection program recently remarked that the biggest problem was the incredible legal fees. In virtually every aspect of collection, the bank needs a lawyer - a lawyer who then winds up charging the bank hour after hour after hour.
Most banks have in-house legal departments staffed by specialists in banking, regulatory, documentation, and securities matters. Few employ litigators. An on-staff litigator could oversee and control the bank's litigation, particularly collection actions.
This specialist would be sufficiently versed to specify motions to be filed, discoveries undertaken, actions commenced, and such. Outside counsel would only execute agreed upon actions.
The litigation manager would work with collection people to determine what they want to accomplish in each case. The manager could then interpret those desires into a legal action plan.
On Paying Lawyers
Another innovation in handling asset quality problems is to change the way the bank pays outside lawyers. Most banks hire lawyers on hourly rates. The lawyer puts in an hour and gets paid for an hour - regardless of the task, regardless of the result. The hour may cost $150, or $250, or $400, depending on who the lawyer is rather than the effectiveness of that hour.
Nor does compensation change with a jury's decision. A bank's quarter or an officer's career may be made or lost by that jury's decision, but not the lawyer's compensation.
Actually, paying hourly rates can be a disincentive. Banks fund the cost of nonperforming assets. So the longer liquidation takes, the less the bank realizes. However, the quicker the lawyer achieves results, the less he or she will be paid.
The Contingent Fee
There are compensation systems that better match the interests of a bank and its attorneys. One such arrangement is the contingent fee. A contingent fee rewards results.
Contingent fees are usually thought of in terms of a specific percentage of the amount collected. In banking, the fee should reflect both the amount collected and the time taken to collect. Instead of a fixed fee, the attorney would accept a floating rate. Counsel might be paid 15% of collection net of expenses made within six months, 12.5% if within one year, and 10% thereafter.
Another approach is a combination fee. In this arrangement, the attorney receives a reduced hourly rate plus a smaller percentage of the collection. For example, a bank might agree to pay half the lawyer's normal hourly charges plus 7.5% of collections achieved within the first six months, 6.25% of collections within a year, and 5% of collections thereafter.
Still another approach is to pay a reduced hourly rate while the matter is progressing and a bonus if the desired result is achieved. The arrangement might entitle the lawyer to two-thirds of the hourly rate while proceedings were under way. If the bank's goal is achieved, the attorney would receive the discounted one-third of the hourly rate and an additional one-third - four-thirds his normal rate.
If the result was unsatisfactory, the attorney would have to settle for the two-thirds already received.
Such arrangements must define the results desired: monies to be collected, property acquired, liability claims to be dismissed, and such. Also, these arrangements must set forth realistic time tables, and the compensations must be spelled out exactly.
Some law firms may balk at these arrangements. But for each firm not interested, a number of others will take advantage of the opportunity for a shot at the bank's business. A bank can spell out its needs and its proposed method of compensation in a simple document.
The bank probably hires its auditors this way. Why not its lawyers?
The banks that solve the non-performing assets problem will be the winners of the 1990s. Solving these problems will require innovation and initiative. The same old approaches just won't work.
Mr. Fellheimer, the former chairman of Equimark Corp., Pittsburgh, is with the law firm of Spector, Gadon & Rosen in Philadelphia.